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A kind of alchemy has been stimulating Brazil’s capital markets over the past year. Once a small, albeit significant, part of the broad, diverse investor universe known as GEMs, for global emerging markets, Brazil has become a major player in the sizzling-hot quartet dubbed BRIC — a sobriquet for the booming economies of Brazil, Russia, India and China.
“The BRIC focus forced many global investors to look at Brazil in a new way,” observes Rio de Janeiro–based Marcelo Mesquita, deputy head of Latin American research for UBS. “When Brazil was merely part of GEM, not BRIC, it was too small for global investors to pay much attention. But now Brazil is on their radar screens.”
And why not? The total market value of Brazilian stocks vaulted 48.8 percent between June 2005 and June 2006 — to 1.3 trillion reais, or roughly $588 billion — as measured by the Brazilian stock market’s benchmark Bolsa de Valores de São Paulo, or Bovespa, index. Bovespa posted its third straight year of impressive gains in 2005, surging 27.7 percent and, as of mid-August, appeared to be well on its way to a fourth.
Rising investor interest in Brazil is further evident in the ballooning size of assets held in Brazilian mutual funds. According to the trade association Investment Company Institute, assets in Brazil-domiciled mutual funds (excluding funds of funds) jumped 37.1 percent last year, to $3.03 billion, up from $2.21 billion in 2004. Net private capital inflows grew dramatically in 2005 as well, reaching $17.2 billion.
Moreover, the number of initial public offerings has been steadily increasing, from seven in 2004 to nine in 2005 to 12 in the first six months of 2006. The IPOs represent companies in all sectors, including homebuilder Gafisa, cable TV provider Vivax, business-software developer Totvs, agribusiness developer Cia. Brasileira de Propriedades Agrícolas and valve maker Lupatech, among others. Many formerly government-owned companies are diving into Brazilian capital markets, too; there has been an unprecedented number of equity offerings, totaling more than $18.7 billion, since 2004, according to Eduardo Sancovsky, head of equity research at Itaú Corretora de Valores in São Paulo.
With so much to cover in Brazil’s surging markets, it’s not surprising that many sell-side organizations are expanding their research teams, mostly by adding junior analysts and other support staff. “The work has increased here because we have more companies to cover,” especially with the growing number of IPOs, says Lika Takahashi, research director at Fator Corretora, a São Paulo brokerage.
All this market expansion is spurring a demand for skilled analysts, many of whom can be found at Banco Pactual, which tops Institutional Investor’s third annual All-Brazil Research Team. The firm, which tied with UBS for second place last year, adds two more team positions this year, for a total of eight. UBS returns in second place, with six total team positions again this year; Credit Suisse, the No. 1–ranked firm for the previous two years, falls to third, with a total of five team positions, down from eight in 2004 and 2005. Rounding out the top five are Itaú Corretora and Merrill Lynch, each of which has four total team positions.
To determine the winners, II polled portfolio managers and analysts at hundreds of institutions that own a total of more than $61 billion in Brazilian equities, representing 66 percent of Bovespa free float, and more than $85 billion in Brazilian debt.
Pactual and UBS stand to tighten their grip on Brazilian research leadership. In May, UBS announced plans to acquire the Rio de Janeiro–based firm for up to $2.6 billion. In accordance with Brazilian law, the deal awaits presidential approval, expected this fall. “We’ll have a combined research force of roughly 30 analysts covering more than 100 Brazilian stocks,” says UBS’s Mesquita, who finishes in third place this year in Equity Strategy. “We’ll also have broader, deeper macro coverage.”
One reason behind this acquisition: to enable UBS to handle the surge of new stock offerings coming onto the Brazilian market, many from companies that are being weaned off government control. Utilities, telecommunications and energy companies fall into this category, including formerly government-owned sanitation and water utility Cia. de Saneamento de Minas Gerais, which held its IPO in February, and Equatorial Energia, which provides electricity to 20 of Brazil’s 27 states. Equatorial Energia acquired formerly state-run Cia. Energética do Maranhão when the latter was privatized in June 2000; Equatorial launched its own IPO in March.
Of the dozen companies that went public in the first half of the year, nine were listed on the Novo Mercado, which Bovespa launched in 2001 to help small, growing companies gain access to capital. Renata Faber of Itaú Corretora, who has the Small-Cap Companies sector all to herself again this year, notes that interest in small caps is growing as investors become more risk tolerant and look for new places to invest. “We haven’t changed the way we work,” Faber says, “but we have had to start working more hours.” She now covers ten of the 33 companies listed on the Novo Mercado and will soon initiate coverage of four more.
Rising levels of disposable income, a strengthening real and easier access to credit have been fueling a spending spree by Brazil’s growing middle class, with stocks of retailers and airlines reaping the rewards of this upward mobility. Lojas Americanas, a popular department store with a strong online presence, has seen its share price nearly double in the past year, from R46.58 in mid-August 2005 to R84.40 a year later.
Gustavo Hungria of Pactual, who leaps from runner-up last year to second team this year, was one of the first Consumer Goods analysts to alert investors to the profit potential. Hungria first called for Lojas Americanas to outperform in December 2004; one month later he upgraded the stock to his top pick and has held that position ever since. Investors who followed Hungria’s advice from its inception would have enjoyed a 108.9 percent return on their investment.
Discount airlines are faring even better. Tam Linhas Aéreas, Brazil’s most popular airline, has seen its shares skyrocket since its June 2005 IPO from R16.73 to R63.00, an increase of nearly 300 percent. The No. 2 airline, Gol Transportes Aéreos, has fared pretty well, too; in the 12 months ended in mid-August, its shares rose from R39.97 to R69.90, a gain of 74.9 percent.
Pactual’s Jander Silveira Medeiros enters this II ranking for the first time, in second place, in the Aerospace, Transportation & Industrials category on the strength of his Tam recommendation. Medeiros thought Tam, the market leader in the discount airline arena, was in a perfect position to pick up customers being displaced by the restructuring and eventual sell-off of rival Viação Aerea Rio Grandense, or Varig Brazilian airlines. He was right: Tam’s market share leapt to 51 percent as of mid-August, up from 43 percent a year earlier.
Besides unprecedented interest from BRIC investors, the Brazilian market has benefited from a wealth of encouraging financial data. Inflation slowed to 5.2 percent in 2005 from 6.1 percent a year earlier, and it is forecast to be 4.0 percent in 2006. The real strengthened to 2.166 against the U.S. dollar through mid-August, from 2.379 per dollar a year earlier. Real average annualized GDP grew 2.5 percent in 2005, down from the previous year’s 4.9 percent, as measured by the Institute of International Finance, which projects a 3.5 percent jump for 2006.
“All the economic fundamentals have improved: inflation, fiscal discipline and so on,” explains Ricardo Kobayashi, Pactual’s director of research and this year’s first-team winner in Equity Strategy. “A higher sustainable GDP growth rate will partly depend on international macro conditions and also how effectively the government incentivizes investments in infrastructure.”
That depends on who’s running the government; presidential elections will be held next month. (The election is scheduled for October 1, but if no candidate receives more than 50 percent of the vote, a run-off will be held on October 29.) President Luiz Inácio Lula da Silva, of the Workers Party, is a leftist and a populist with strong support among Brazil’s poor. His own government statistics report that over the past year, 7 million impoverished Brazilians out of a total population of 170 million moved up to the middle class. Unemployment is lower and access to credit broader. Consumer prices rose 5.7 percent in 2005, an improvement from the previous year’s 7.5 percent increase.
Lula is being challenged by former São Paulo governor Geraldo Alckmin of the centrist Social Democratic Party. A survey of registered voters by Brazilian polling agency DataFolha, released on August 22, showed Lula ahead of Alckmin, 49 percent to 25 percent, but the incumbent is still shy of the majority needed to avoid a run-off election.
Whatever the outcome, Kobayashi believes that the elections “should have positive effects on the market.” Both candidates, he says, proclaim commitment to “fiscal discipline, continued inflation-control and needed reforms.” Given Brazil’s many financial improvements over the past few years, the possibilities for its future may indeed be limitless. Still, Kobayashi’s colleague Guilherme Bacha de Almeida, lead economist at Pactual and the top-ranked economist in this year’s survey, remains concerned that Brazil’s GDP growth still lags behind those of other emerging markets. “This seems to be the biggest challenge for the next administration: reinforcing the bridge to stronger growth,” Bacha says.
